Costly Assumptions – The Number One Reason Startups Fail

Recently, two startups of friends closed their doors within 3 months of the launch of their businesses. Both were hard working owners who invested considerable money and research before they opened their doors, or so they thought. Both invested their savings and borrowed funds into these ventures.

Both had one key flaw – Optimistic and fatal assumptions.

One was a Pilate’s studio in a suburban community– the facility was beautiful, and spacious. A sizable amount of the owner’s capital was invested in leasehold improvements (which is money you never get back) and state of the art equipment. The downside of this location was its visibility – it could only be seen from a major interstate highway as drivers whizzed by and had no other storefront for local traffic to even know it existed.

The fatal assumption was the business model itself. The plan was to hire instructors with an existing following, which didn’t happen and with only one instructor the owner immediately fell behind on his sizable rent, utilities and the loan he took out to buy the equipment.It was clear the monthly the burn rate was beyond his comfort zone and he decided to close the doors.

The other company sold cold brew, iced coffee and other drinks from a bicycle cart and the plan was to have at least a dozen carts operating throughout the city within the first 60 days.

The fatal assumption – they could rent space in high traffic trailer food parks for about $500 per month. They made this assumption because they required no utilities and took up little or no space. To their dismay they discovered they could not find a single space for less than $1500 per month. Also, their prototype bike did not initially meet city health codes and lost 8 weeks putting sinks onto the vehicle. Finally they were given a permit for one location from the city by a train station that was only busy twice a day – period.

These assumptions were sadly incomplete and overly optimistic.

The good news is they both failed fast and cut their losses.

The bad news is they now have a considerable debt to pay off.

With the benefit of hindsight these assumptions may seem like blatant oversights in due diligence, yet they are typical mistakes so many start-ups make.

In my experience it generally takes a minimum of 2.20 – 5 more time and money then originally projected to cover the initial costs of a startups and to find ways to overcome costly miscalculations.

I believe the two worst things that can happen to a startup is to have either too much or too little money.

If you have too much you spend more than you need too quickly and not always wisely. It’s only after you run out of capital that you realize where you really need to spend it. This is costly money because you now have debt to pay back or you have squandered equity capital.

If you have too little you may run out of money before you go from learning to earning and you’re broke.

I spoke to an ambitious start up a year ago who told me her primary focus was raising and burning two million dollars in the first 24 months – I asked her, could she do it if she only had 1.5 million – she said yes – I replied, then why not do it for 1.5 and prove the model instead of burning so much capital?

Whether you are seeking investors, bank financing or you are your own investor; present your business model to investors or savvy business owners before you start spending or bootstrap a beta test, and you will have the benefit of fresh and questioning eyes to help you see or examine assumptions you have overlooked.

Choose several advisors who are already in the industry and understand the business – invite them to tear your model apart.Before you meet with them, answer the questions below so you are prepared.

NOTE:

Put it in writing

Don’t request an NDA (Non-Disclosure Agreements are not necessary in this case – frankly, ideas are a dime a dozen, so you have no need to require one.)

Most start-ups don’t know what they don’t know – they need to gain humility

PURPOSE

What do you want to accomplish?

What is the current opportunity, or conversely, what is the problem you are trying to solve?

How will you make it happen?

Why is it important?

PROCESS

How will you set up your operation?

Is there infrastructure (personnel and expertise) in place to handle the opportunity?If not, how will you acquire the expertise you require?

What about the physical location?

Is it ready for business

Will it require enhancements

Are capital improvements necessary to open

What are the cost and the time constraints

How will the success of the opportunity be measured?

Profitability

Brand and market position

Return on investment

Increase new customers

Increase customer retention and satisfaction

Break even point

PEOPLE

What is the approximate customer demand for the product and service?

Have you qualified potential customer demand with:

Small scale customer surveys and interviews

Focus groups

Secondary research such as statistics and demographics

Concept testing

How much are customers willing to pay for the product or services?

Will the opportunity (new or enhanced) target current customers or a new customer base?

How much will it cost to acquire these new customers? How much will you spend on marketing and advertising to reach these new customers?

How many employees will need to be hired?

How much will it cost (salary and benefits) to hire these new people?

What is the cost of supplies (computers, cell phones, business cards, and furniture) for these new employees?

How will it impact your life?

Will it mean an increase in time away from friends, family, and personal interests?

Will you be risking capital that you have already saved?

TIME

What is your time frame?

When will you launch?

What are your targets?

How long to you plain to remain pre-profit?

How will you make it happen? Why is it important?

Finally, go to experts; be open to the knowledge they can impart understanding that finding humility can be expensive and they can help point out flaws in your answers keeping you from making costly inaccurate assumptions